The Consequences Have Started to Arrive

The consequences of adopting a weak dollar and inflationary monetary policy
to bail out the economy have begun to manifest themselves, although the real
effects of the government's $12.8 trillion dollar recovery plan have only just
started to show up. Investors should not be surprised to learn that the commitments,
guarantees, and prodigal spending of the past two Administrations have come
with harrowing consequences. Surprising or not, these painful consequences
are just beginning to appear and are rather insidious in nature.

But the regular readers of my commentaries had been warned that massive money
printing and government incursions into the free market would spark higher
inflation and a falling dollar. To illustrate the point, the price of oil has
increased 53% this year while gasoline has increased 26% in price since May
1st. That move alone should start to ring the alarm bells for everyone. But
commodity prices have risen across the board sending the CRB Index up 14% in
May alone. In addition, copper is up over 60% this year while cotton is up
18% in 2009 and the US dollar has also lost about 10% of its value since early
March. So much for the deflation argument!

The cause of steep rises in basic materials and energy is not so much a U.S.
demand story. Asia seems to be faring better; (their economy expanded at a
6.1% annual rate in Q1, the slowest rate in 10 years) while our economy has
shed over 6 million jobs since the recession began and GDP contracted at a
5.7% annual rate in the first quarter. But the real cause in the rise of commodities
can be found in the weakness of the US dollar.

Even with all of this in mind, the biggest negative effect thus far from the
Administration's profligacy has shown up in surging bond yields. After hitting
a secular low of 2.5% on the 10 year note, yields jumped to 3.9%! Meanwhile,
mortgage rates leapt from a low of 4.85% to 5.45% last week, following the
move in Treasuries.

Therein lays the problem. The progenitor of this crisis was a collapse in
real estate prices and it has shown only a few signs of stabilization in sales,
but is still far from a marked recovery in prices. In fact, last month's report
on existing home sales showed a drop of 15.4% Y.O.Y. Both mortgage delinquencies
and foreclosures reached record levels in Q1 2009 while the months' supply
of existing homes actually climbed to 10.2 from 9.6. So while mortgage rates
are on the rise, housing fundamentals continue to exhibit weakness.

Those soaring bond yields and mortgage rates will wreak havoc on our debt-imbued
economy. Already we saw a report by the Mortgage Bankers Association showing
a drop of 16% in the Refinance and Purchase Index for the week ending May 29th.
For an economy that has a total debt to GDP ratio of 370%, we can also expect
dire repercussions in everything from credit card loans to municipal bonds.

This is why Mr. Bernanke's next move on quantitative easing is so critical.
Wednesday's auction of $19 billion in 10 year notes and Thursday's auction
of $11 billion in 30 year bonds will be viewed with great anticipation. If
Banana Ben steps up his manipulation of bond prices, the current fall in the
dollar along with the rise in commodity prices and interest rates will seem
inconsequential by comparison in the not too distant future.

Our government risks morphing what would have been a severe deflationary recession
into an inflationary recession/depression in the longer term. Their decision
to choose the inflationary route is based on the fact that inflation bails
out those in debt. Make no mistake, for a country with $11.4 trillion in debt
and a 2009 deficit equal to 13% of GDP, inflation is perceived as the only
way out. However, inflation can never bail out anything or anyone, it only
helps the very rich maintain their purchasing power while robbing it from the
rest of the country. It will also be at the great expense of those who have
made the mistake of holding their savings in dollar denominated fixed income
instruments and who have not protected themselves by owning hard assets.

With more than 16 years of industry experience, Michael Pento acts as chief
economist for Delta Global Advisors and is a contributing writer for GreenFaucet.com.
He is a well-established specialist in the Austrian School of economic theory
and a regular guest on CNBC and other national media outlets. Mr. Pento has
worked on the floor of the N.Y.S.E. as well as serving as vice president of
investments for GunnAllen Financial immediately prior to joining Delta Global.